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e-CFR data is current as of September 29, 2020

Title 12Chapter IISubchapter APart 217Subpart E → Subject Group


Title 12: Banks and Banking
PART 217—CAPITAL ADEQUACY OF BANK HOLDING COMPANIES, SAVINGS AND LOAN HOLDING COMPANIES, AND STATE MEMBER BANKS (REGULATION Q)
Subpart E—Risk-Weighted Assets—Internal Ratings-Based and Advanced Measurement Approaches


Risk-Weighted Assets for Equity Exposures

§217.151   Introduction and exposure measurement.

(a) General. (1) To calculate its risk-weighted asset amounts for equity exposures that are not equity exposures to investment funds, a Board-regulated institution may apply either the Simple Risk Weight Approach (SRWA) in §217.152 or, if it qualifies to do so, the Internal Models Approach (IMA) in §217.153. A Board-regulated institution must use the look-through approaches provided in §217.154 to calculate its risk-weighted asset amounts for equity exposures to investment funds.

(2) A Board-regulated institution must treat an investment in a separate account (as defined in §217.2), as if it were an equity exposure to an investment fund as provided in §217.154.

(3) Stable value protection. (i) Stable value protection means a contract where the provider of the contract is obligated to pay:

(A) The policy owner of a separate account an amount equal to the shortfall between the fair value and cost basis of the separate account when the policy owner of the separate account surrenders the policy, or

(B) The beneficiary of the contract an amount equal to the shortfall between the fair value and book value of a specified portfolio of assets.

(ii) A Board-regulated institution that purchases stable value protection on its investment in a separate account must treat the portion of the carrying value of its investment in the separate account attributable to the stable value protection as an exposure to the provider of the protection and the remaining portion of the carrying value of its separate account as an equity exposure to an investment fund.

(iii) A Board-regulated institution that provides stable value protection must treat the exposure as an equity derivative with an adjusted carrying value determined as the sum of §217.151(b)(1) and (2).

(b) Adjusted carrying value. For purposes of this subpart, the adjusted carrying value of an equity exposure is:

(1) For the on-balance sheet component of an equity exposure, the Board-regulated institution's carrying value of the exposure;

(2) For the off-balance sheet component of an equity exposure, the effective notional principal amount of the exposure, the size of which is equivalent to a hypothetical on-balance sheet position in the underlying equity instrument that would evidence the same change in fair value (measured in dollars) for a given small change in the price of the underlying equity instrument, minus the adjusted carrying value of the on-balance sheet component of the exposure as calculated in paragraph (b)(1) of this section.

(3) For unfunded equity commitments that are unconditional, the effective notional principal amount is the notional amount of the commitment. For unfunded equity commitments that are conditional, the effective notional principal amount is the Board-regulated institution's best estimate of the amount that would be funded under economic downturn conditions.

§217.152   Simple risk weight approach (SRWA).

(a) General. Under the SRWA, a Board-regulated institution's aggregate risk-weighted asset amount for its equity exposures is equal to the sum of the risk-weighted asset amounts for each of the Board-regulated institution's individual equity exposures (other than equity exposures to an investment fund) as determined in this section and the risk-weighted asset amounts for each of the Board-regulated institution's individual equity exposures to an investment fund as determined in §217.154.

(b) SRWA computation for individual equity exposures. A Board-regulated institution must determine the risk-weighted asset amount for an individual equity exposure (other than an equity exposure to an investment fund) by multiplying the adjusted carrying value of the equity exposure or the effective portion and ineffective portion of a hedge pair (as defined in paragraph (c) of this section) by the lowest applicable risk weight in this section.

(1) Zero percent risk weight equity exposures. An equity exposure to an entity whose credit exposures are exempt from the 0.03 percent PD floor in §217.131(d)(2) is assigned a zero percent risk weight.

(2) 20 percent risk weight equity exposures. An equity exposure to a Federal Home Loan Bank or the Federal Agricultural Mortgage Corporation (Farmer Mac) is assigned a 20 percent risk weight.

(3) 100 percent risk weight equity exposures. The following equity exposures are assigned a 100 percent risk weight:

(i) Community development equity exposures. (A) For state member banks and bank holding companies, an equity exposure that qualifies as a community development investment under 12 U.S.C. 24 (Eleventh), excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a consolidated small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).

(B) For savings and loan holding companies, an equity exposure that is designed primarily to promote community welfare, including the welfare of low- and moderate-income communities or families, such as by providing services or employment, and excluding equity exposures to an unconsolidated small business investment company and equity exposures held through a small business investment company described in section 302 of the Small Business Investment Act of 1958 (15 U.S.C. 682).

(ii) Effective portion of hedge pairs. The effective portion of a hedge pair.

(iii) Non-significant equity exposures. Equity exposures, excluding significant investments in the capital of an unconsolidated institution in the form of common stock and exposures to an investment firm that would meet the definition of a traditional securitization were it not for the Board's application of paragraph (8) of that definition in §217.2 and has greater than immaterial leverage, to the extent that the aggregate adjusted carrying value of the exposures does not exceed 10 percent of the Board-regulated institution's total capital.

(A) To compute the aggregate adjusted carrying value of a Board-regulated institution's equity exposures for purposes of this section, the Board-regulated institution may exclude equity exposures described in paragraphs (b)(1), (b)(2), (b)(3)(i), and (b)(3)(ii) of this section, the equity exposure in a hedge pair with the smaller adjusted carrying value, and a proportion of each equity exposure to an investment fund equal to the proportion of the assets of the investment fund that are not equity exposures or that meet the criterion of paragraph (b)(3)(i) of this section. If a Board-regulated institution does not know the actual holdings of the investment fund, the Board-regulated institution may calculate the proportion of the assets of the fund that are not equity exposures based on the terms of the prospectus, partnership agreement, or similar contract that defines the fund's permissible investments. If the sum of the investment limits for all exposure classes within the fund exceeds 100 percent, the Board-regulated institution must assume for purposes of this section that the investment fund invests to the maximum extent possible in equity exposures.

(B) When determining which of a Board-regulated institution's equity exposures qualifies for a 100 percent risk weight under this section, a Board-regulated institution first must include equity exposures to unconsolidated small business investment companies or held through consolidated small business investment companies described in section 302 of the Small Business Investment Act, then must include publicly traded equity exposures (including those held indirectly through investment funds), and then must include non-publicly traded equity exposures (including those held indirectly through investment funds).

(4) 250 percent risk weight equity exposures. Significant investments in the capital of unconsolidated financial institutions in the form of common stock that are not deducted from capital pursuant to §217.22(b)(4) are assigned a 250 percent risk weight.

(5) 300 percent risk weight equity exposures. A publicly traded equity exposure (other than an equity exposure described in paragraph (b)(7) of this section and including the ineffective portion of a hedge pair) is assigned a 300 percent risk weight.

(6) 400 percent risk weight equity exposures. An equity exposure (other than an equity exposure described in paragraph (b)(7) of this section) that is not publicly traded is assigned a 400 percent risk weight.

(7) 600 percent risk weight equity exposures. An equity exposure to an investment firm that:

(i) Would meet the definition of a traditional securitization were it not for the Board's application of paragraph (8) of that definition in §217.2; and

(ii) Has greater than immaterial leverage is assigned a 600 percent risk weight.

(c) Hedge transactions—(1) Hedge pair. A hedge pair is two equity exposures that form an effective hedge so long as each equity exposure is publicly traded or has a return that is primarily based on a publicly traded equity exposure.

(2) Effective hedge. Two equity exposures form an effective hedge if the exposures either have the same remaining maturity or each has a remaining maturity of at least three months; the hedge relationship is formally documented in a prospective manner (that is, before the Board-regulated institution acquires at least one of the equity exposures); the documentation specifies the measure of effectiveness (E) the Board-regulated institution will use for the hedge relationship throughout the life of the transaction; and the hedge relationship has an E greater than or equal to 0.8. A Board-regulated institution must measure E at least quarterly and must use one of three alternative measures of E:

(i) Under the dollar-offset method of measuring effectiveness, the Board-regulated institution must determine the ratio of value change (RVC). The RVC is the ratio of the cumulative sum of the periodic changes in value of one equity exposure to the cumulative sum of the periodic changes in the value of the other equity exposure. If RVC is positive, the hedge is not effective and E equals zero. If RVC is negative and greater than or equal to −1 (that is, between zero and −1), then E equals the absolute value of RVC. If RVC is negative and less than −1, then E equals 2 plus RVC.

(ii) Under the variability-reduction method of measuring effectiveness:

eCFR graphic er11oc13.055.gif

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(iii) Under the regression method of measuring effectiveness, E equals the coefficient of determination of a regression in which the change in value of one exposure in a hedge pair is the dependent variable and the change in value of the other exposure in a hedge pair is the independent variable. However, if the estimated regression coefficient is positive, then the value of E is zero.

(3) The effective portion of a hedge pair is E multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair.

(4) The ineffective portion of a hedge pair is (1-E) multiplied by the greater of the adjusted carrying values of the equity exposures forming a hedge pair.

[Reg. Q, 78 FR 62157, 62285, Oct. 11, 2013, as amended at 78 FR 62289, Oct. 11, 2013; 84 FR 35269, July 22, 2019]

§217.153   Internal models approach (IMA).

(a) General. A Board-regulated institution may calculate its risk-weighted asset amount for equity exposures using the IMA by modeling publicly traded and non-publicly traded equity exposures (in accordance with paragraph (c) of this section) or by modeling only publicly traded equity exposures (in accordance with paragraphs (c) and (d) of this section).

(b) Qualifying criteria. To qualify to use the IMA to calculate risk-weighted assets for equity exposures, a Board-regulated institution must receive prior written approval from the Board. To receive such approval, the Board-regulated institution must demonstrate to the Board's satisfaction that the Board-regulated institution meets the following criteria:

(1) The Board-regulated institution must have one or more models that:

(i) Assess the potential decline in value of its modeled equity exposures;

(ii) Are commensurate with the size, complexity, and composition of the Board-regulated institution's modeled equity exposures; and

(iii) Adequately capture both general market risk and idiosyncratic risk.

(2) The Board-regulated institution's model must produce an estimate of potential losses for its modeled equity exposures that is no less than the estimate of potential losses produced by a VaR methodology employing a 99th percentile one-tailed confidence interval of the distribution of quarterly returns for a benchmark portfolio of equity exposures comparable to the Board-regulated institution's modeled equity exposures using a long-term sample period.

(3) The number of risk factors and exposures in the sample and the data period used for quantification in the Board-regulated institution's model and benchmarking exercise must be sufficient to provide confidence in the accuracy and robustness of the Board-regulated institution's estimates.

(4) The Board-regulated institution's model and benchmarking process must incorporate data that are relevant in representing the risk profile of the Board-regulated institution's modeled equity exposures, and must include data from at least one equity market cycle containing adverse market movements relevant to the risk profile of the Board-regulated institution's modeled equity exposures. In addition, the Board-regulated institution's benchmarking exercise must be based on daily market prices for the benchmark portfolio. If the Board-regulated institution's model uses a scenario methodology, the Board-regulated institution must demonstrate that the model produces a conservative estimate of potential losses on the Board-regulated institution's modeled equity exposures over a relevant long-term market cycle. If the Board-regulated institution employs risk factor models, the Board-regulated institution must demonstrate through empirical analysis the appropriateness of the risk factors used.

(5) The Board-regulated institution must be able to demonstrate, using theoretical arguments and empirical evidence, that any proxies used in the modeling process are comparable to the Board-regulated institution's modeled equity exposures and that the Board-regulated institution has made appropriate adjustments for differences. The Board-regulated institution must derive any proxies for its modeled equity exposures and benchmark portfolio using historical market data that are relevant to the Board-regulated institution's modeled equity exposures and benchmark portfolio (or, where not, must use appropriately adjusted data), and such proxies must be robust estimates of the risk of the Board-regulated institution's modeled equity exposures.

(c) Risk-weighted assets calculation for a Board-regulated institution using the IMA for publicly traded and non-publicly traded equity exposures. If a Board-regulated institution models publicly traded and non-publicly traded equity exposures, the Board-regulated institution's aggregate risk-weighted asset amount for its equity exposures is equal to the sum of:

(1) The risk-weighted asset amount of each equity exposure that qualifies for a 0 percent, 20 percent, or 100 percent risk weight under §217.152(b)(1) through (b)(3)(i) (as determined under §217.152) and each equity exposure to an investment fund (as determined under §217.154); and

(2) The greater of:

(i) The estimate of potential losses on the Board-regulated institution's equity exposures (other than equity exposures referenced in paragraph (c)(1) of this section) generated by the Board-regulated institution's internal equity exposure model multiplied by 12.5; or

(ii) The sum of:

(A) 200 percent multiplied by the aggregate adjusted carrying value of the Board-regulated institution's publicly traded equity exposures that do not belong to a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under §217.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund;

(B) 200 percent multiplied by the aggregate ineffective portion of all hedge pairs; and

(C) 300 percent multiplied by the aggregate adjusted carrying value of the Board-regulated institution's equity exposures that are not publicly traded, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under §217.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund.

(d) Risk-weighted assets calculation for a Board-regulated institution using the IMA only for publicly traded equity exposures. If a Board-regulated institution models only publicly traded equity exposures, the Board-regulated institution's aggregate risk-weighted asset amount for its equity exposures is equal to the sum of:

(1) The risk-weighted asset amount of each equity exposure that qualifies for a 0 percent, 20 percent, or 100 percent risk weight under §§217.152(b)(1) through (b)(3)(i) (as determined under §217.152), each equity exposure that qualifies for a 400 percent risk weight under §217.152(b)(5) or a 600 percent risk weight under §217.152(b)(6) (as determined under §217.152), and each equity exposure to an investment fund (as determined under §217.154); and

(2) The greater of:

(i) The estimate of potential losses on the Board-regulated institution's equity exposures (other than equity exposures referenced in paragraph (d)(1) of this section) generated by the Board-regulated institution's internal equity exposure model multiplied by 12.5; or

(ii) The sum of:

(A) 200 percent multiplied by the aggregate adjusted carrying value of the Board-regulated institution's publicly traded equity exposures that do not belong to a hedge pair, do not qualify for a 0 percent, 20 percent, or 100 percent risk weight under §217.152(b)(1) through (b)(3)(i), and are not equity exposures to an investment fund; and

(B) 200 percent multiplied by the aggregate ineffective portion of all hedge pairs.

§217.154   Equity exposures to investment funds.

(a) Available approaches. (1) Unless the exposure meets the requirements for a community development equity exposure in §217.152(b)(3)(i), a Board-regulated institution must determine the risk-weighted asset amount of an equity exposure to an investment fund under the full look-through approach in paragraph (b) of this section, the simple modified look-through approach in paragraph (c) of this section, or the alternative modified look-through approach in paragraph (d) of this section.

(2) The risk-weighted asset amount of an equity exposure to an investment fund that meets the requirements for a community development equity exposure in §217.152(b)(3)(i) is its adjusted carrying value.

(3) If an equity exposure to an investment fund is part of a hedge pair and the Board-regulated institution does not use the full look-through approach, the Board-regulated institution may use the ineffective portion of the hedge pair as determined under §217.152(c) as the adjusted carrying value for the equity exposure to the investment fund. The risk-weighted asset amount of the effective portion of the hedge pair is equal to its adjusted carrying value.

(b) Full look-through approach. A Board-regulated institution that is able to calculate a risk-weighted asset amount for its proportional ownership share of each exposure held by the investment fund (as calculated under this subpart E of this part as if the proportional ownership share of each exposure were held directly by the Board-regulated institution) may either:

(1) Set the risk-weighted asset amount of the Board-regulated institution's exposure to the fund equal to the product of:

(i) The aggregate risk-weighted asset amounts of the exposures held by the fund as if they were held directly by the Board-regulated institution; and

(ii) The Board-regulated institution's proportional ownership share of the fund; or

(2) Include the Board-regulated institution's proportional ownership share of each exposure held by the fund in the Board-regulated institution's IMA.

(c) Simple modified look-through approach. Under this approach, the risk-weighted asset amount for a Board-regulated institution's equity exposure to an investment fund equals the adjusted carrying value of the equity exposure multiplied by the highest risk weight assigned according to subpart D of this part that applies to any exposure the fund is permitted to hold under its prospectus, partnership agreement, or similar contract that defines the fund's permissible investments (excluding derivative contracts that are used for hedging rather than speculative purposes and that do not constitute a material portion of the fund's exposures).

(d) Alternative modified look-through approach. Under this approach, a Board-regulated institution may assign the adjusted carrying value of an equity exposure to an investment fund on a pro rata basis to different risk weight categories assigned according to subpart D of this part based on the investment limits in the fund's prospectus, partnership agreement, or similar contract that defines the fund's permissible investments. The risk-weighted asset amount for the Board-regulated institution's equity exposure to the investment fund equals the sum of each portion of the adjusted carrying value assigned to an exposure class multiplied by the applicable risk weight. If the sum of the investment limits for all exposure types within the fund exceeds 100 percent, the Board-regulated institution must assume that the fund invests to the maximum extent permitted under its investment limits in the exposure type with the highest risk weight under subpart D of this part, and continues to make investments in order of the exposure type with the next highest risk weight under subpart D of this part until the maximum total investment level is reached. If more than one exposure type applies to an exposure, the Board-regulated institution must use the highest applicable risk weight. A Board-regulated institution may exclude derivative contracts held by the fund that are used for hedging rather than for speculative purposes and do not constitute a material portion of the fund's exposures.

§217.155   Equity derivative contracts.

(a) Under the IMA, in addition to holding risk-based capital against an equity derivative contract under this part, a Board-regulated institution must hold risk-based capital against the counterparty credit risk in the equity derivative contract by also treating the equity derivative contract as a wholesale exposure and computing a supplemental risk-weighted asset amount for the contract under §217.132.

(b) Under the SRWA, a Board-regulated institution may choose not to hold risk-based capital against the counterparty credit risk of equity derivative contracts, as long as it does so for all such contracts. Where the equity derivative contracts are subject to a qualified master netting agreement, a Board-regulated institution using the SRWA must either include all or exclude all of the contracts from any measure used to determine counterparty credit risk exposure.

§§217.156-217.160   [Reserved]

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